Modifications: Still Quantifying What is Doable

The Home Affordable Modification program is challenging lenders and servicers with the goal to assist up to 9 million distressed borrowers. Is this number realistic or misleading?

Market veterans like Tim Anderson, president of Houston-based e-mortgage services provider SigniaDocs, are a little skeptical about the scale of modifications.

"The numbers will vary depending upon the type of modification, how they [borrowers] were contacted and most importantly, how easy it was to execute once received," he said. He finds it difficult to evaluate what is doable and what is not doable in modifications also because there is not much data on the latest Federal program, the Home Affordability and Stability Plan, which was unveiled in February this year.

What is well known and clear about the $75 billion multipronged Obama plan is that it seeks to help millions of homeowners. The foreclosure fix effort is quite different from the Bush administration's approach that relied mainly on having servicers voluntarily modify troubled mortgages. It makes it easier for homeowners to either refinance or have their mortgage loans modified so they can afford them. Help is on the way since the president has vastly broadened the scope of the government rescue by focusing on homeowners who are still current in their payments but at risk of default.

Plus, billions of federal funds offer a sizable incentive for servicers promoting the modification of delinquent loans of those who have given up and have already stopped paying the mortgage. The voluntary program often referred to as "a mix of carrots and sticks" offers servicers $1,000 for each modification, and another $1,000 a year for three years if the borrower stays current. It also gives $500 to servicers and $1,500 to mortgage holders if they modify at-risk not yet delinquent loans.

Is that enough to generate the scale of modifications expected and most importantly, up to the aforementioned 9 million?

To some the bar has been set up too high if one takes into consideration the inherent risk of redefaults because of still high unemployment rates and the overall economic crisis.

To that end Mr. Anderson quoted Laurie Goodman, senior managing director of Amherst Securities, who presented the some statistics at the recent DARE Conference in New York on May 13.

Ms. Goodman's findings showed that in modifications that involved a reduction in capital, 53% of the borrowers redefault in three months, in those that involved a principle reduction 31% redefault in three months, 40% follow suit when the interest rate was reduced and 38% if it was a combination of rate and principle reduction.

She also reported that in six months the performance of these same programs was a 72% redefault rate on capital reduction, only 44% of principal, 57% on interest and 56% on the rate and principle reduction combination.

As to how bad can the rate of mortgage defaults get, in its June 2009 report, University Financial Associates states, "An important risk management exercise is to simulate a worst-case scenario."

UFA is known for the various simulations it runs each quarter to help risk managers understand future default risks. In UFA's recent "worst case" scenario, GDP will decline 5% for two years, followed by two more years of positive 1% growth before returning to trend growth. "The worst-case scenario is much worse than any of the post-war recessions but far better than the 1930s."

In a worst-case scenario, UFA's Default Risk Index - which tracks the impact of local and national economic conditions on expected life-of-loan defaults by vintage - peaks at 376 in 1Q09, while in the baseline scenario it peaks in 4Q08 at 279. In a worst-case scenario, the index estimates the risk of default on newly originated nonprime mortgages as 276% higher than the average of the 1990s. Compare this number with the baseline index, which peaks at 179% higher than the 1990's average.

"Even in a worst-case scenario, the worst vintages are already behind us. However, the worst case is a third worse than a baseline scenario," UFA said.

Even if the worst is over, achieving sustainable modifications is the key to a healthier marketplace.

"Right now, most data would support the principle reduction method as the most workable, as this might more directly affect and address the one in five homes that are currently underwater in this country as well," Mr. Anderson says.

Another significant indicator, he adds, is "a correlation in success rates directly related to how easy and fast the transaction occurs. If a lender sends out paper documents, it is taking from 30 to 60 days on average to get the modification completed."

Obviously technology plays an important role in today's modifications. Very significantly, the executive says, SigniaDocs is finding that if the loan modification is done online, almost 50% will immediately execute the documents via eSign (a "click to sign" technology) within minutes after they have been qualified and approved for a mod program. Over 80% will execute the electronic document by the next day.

"This is a huge improvement over the old paper processes that many lenders are still using to address the backlog today," he said.

Other servicing shops report heartening results.

"In our portfolio of highly delinquent first and second mortgages, we are able to workout about 75% of loans for the borrowers we interact with," says Steve Horne, CEO of Wingspan Portfolio Advisors, a Dallas-based servicer of severely delinquent loans. "Of the workouts, approximately 70% are modifications or repayment plans leading to modifications. Thus for every borrower we speak with, a little over 50% result in loan mods."